Investment Comment: How to invest in markets that are now hitting all-time highs

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Patrick Connolly

The UK and US are consistently beating growth expectations – but sensible investors should proceed with caution

THE GOOD news? The UK economy is recovering very well, consistently beating growth expectations. We’re seeing increasing levels of merger and acquisition activity, while the FTSE 100, S&P 500 and Dow Jones indices have all been at, or near, all-time highs in recent weeks.

However, equity investors should proceed with caution. It’s all too easy to buy at the top of the market, and there’s a feeling among some fund managers at the moment that much of the positive global economic news may already be factored in to share prices. That’s not to say that stocks won’t go any higher. But valuations are stretched, and sensible investors will want to take steps to avoid mis-timing the market.

POSITIVE INVESTMENT ENVIRONMENT
In the UK, the unemployment rate is down to just 6.8 per cent – an indication of how far we’ve come, and how quickly the economic situation has changed. We’re seeing improving confidence among UK consumers and employers (the YouGov/Cebr Consumer Confidence Index recently hit its highest level since August 2007). And such is the buoyancy of the UK housing market, particularly in London, that commentators now talk of a house price bubble.

At Chase de Vere, we like the Investec UK Special Situations fund. Manager Alastair Mundy takes a contrarian approach, looking for good quality companies which are undervalued. It has seen 6.4 per cent growth in the past 12 months. That said, we tend to use passive vehicles for UK large cap investing: it’s an efficient area where active managers will struggle to outperform.

BEYOND BRITAIN
But the good news isn’t confined to the UK. The US economy is leading the global recovery, despite a growth setback in the first quarter. The S&P 500 shot up 30 per cent in 2013, leading some to believe it is ready for a correction. But the US could still offer good returns. It is benefiting from a recovering housing market, better bank behaviour and normal lending, a renaissance in manufacturing, and a rise in consumer confidence.

We like the HSBC American Index fund. It’s cheap, and has very experienced managers. If it’s an active fund investors seek, we like the Axa Framlington American Growth fund – which usually has a fair amount invested in technology and consumer discretionary stocks, and takes advantage of shale gas and oil exploration.

And while the US central bank is scaling back its QE programme, we could see further action from the European Central Bank. Indeed, according to HSBC, the cyclically adjusted price-earnings multiple shows that with the exception of the second quarter of 2013, European equities are now at their cheapest level compared to US shares since 1993.

RECORD LEVELS
And market sentiment has improved in this accommodative environment. Equity investors, in particular, have benefitted from central bank support. A number of markets are at or around record levels, including those in the UK and US.

With all this good news, surely now is a good time to invest? The latest statistics from the Investment Management Association (IMA) suggest that’s precisely what people are doing. In March, equities were the best selling asset class in investment funds, with net retail sales of £952m. To put this into context, this is ten times more than the corresponding figure in March 2013.

PROCEED WITH CAUTION
Unfortunately, investors have an uncanny knack of jumping in at the wrong time. The result is that too many people buy at the top of the market or, worse, sell at the bottom. They wrongly see raging stock markets as an invitation to pile in, rather than a warning sign that many of the likely gains may have already been made. The valuations of many stocks now look stretched – the S&P 500 currently trades at 25.37 on the Shiller price-to-earnings ratio, compared to a historical mean of 16.57 – and we need to see improving earnings to justify these valuations. There is no guarantee this will happen.

Markets cannot keep ignoring the risks, and changes in sentiment tend to happen very quickly. To quote economist John Kenneth Galbraith, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” What we do know is that March 2009 was a very good time to invest, and those jumping in now have missed out on gains of approaching 100 per cent since.

One way the higher-risk investor can combat this is by increasing their exposure in other areas, like emerging markets. While the premier emerging market managers – Aberdeen and First State – have soft-closed, the JP Morgan Emerging Markets fund has an experienced manager who avoids taking big bets.

A LONG-TERM APPROACH
Markets may go higher from here, but there is more of a risk that they will fall. Investors can adopt a tactical approach – trying to time markets by selling out at the top and then buying again at cheaper prices. But very few manage to do this successfully.

It’s usually better to adopt a long-term approach, sticking with shares through thick and thin, and rebalancing regularly by taking profits from those areas which have performed well and reinvesting money in those that haven’t. You can also reduce risks by investing in other asset classes such as fixed income and property alongside equities. In property, we only use (active) funds that invest in bricks-and-mortar, as they is far less correlated to other investments than property shares. We like M&G Property Portfolios, which saw 9.1 per cent growth in the past 12 months compared to a 3.1 per cent sector average.

And if investing new money, you can do this on a monthly basis to negate the risk of market timing. Equities can still offer good prospects, but you might be thankful if you also take steps to manage potential downside risks.